Suppose you uncover good news about a stock's fundamental value. When you start trading on this information, market makers will notice a spike in aggregate demand, infer that someone must have discovered good news, and adjust the stock's price upward … [Continue reading]
Empirical Bayes and Price Signals
Asset-pricing models are built upon the idea that traders learn from price signals. For example, suppose there are $N \geq 1$ actively managed mutual funds. And, imagine a trader that observes the entire cross-section of these mutual funds' returns … [Continue reading]
How Bad Are False Positives, Really?
Imagine you're looking for variables that predict the cross-section of expected returns. No search process is perfect. As you work, you will inevitably uncover both tradable anomalies as well as spurious correlations. To figure out which are which, … [Continue reading]
How Many Assets Are Needed To Test a K-Factor Model?
1. Motivation Imagine you're a financial economist who thinks that some risk factor,${\color{white}i}f_t$, explains the cross-section of expected returns. And, you decide to test your hunch. First, you regress the realized returns of $N$ different … [Continue reading]
Neglecting The Madness Of Crowds
Motivation This post is motivated by two stylized facts about bubbles and crashes. The first is that these events are often attributed to the madness of crowds. In popular accounts, they occur when a large number of inexperienced traders floods into … [Continue reading]